Forex can be extremely profitable for successful trades with many brokers offering leverage of many hundreds of times the value of the deposit within an account. This leverage means that a trader can magnify the gains made from each movement in the currency markets. An example of this would be a position of $100 which, with leverage of 1:500 allowing a $50000 position to be controlled. Each positive or negative price movement in the forex market will be based on this larger value, and therefore magnify both profits and losses for a trader. Whilst the profits can be many times more than the initial $100 purchase, this can also apply to losses. It is therefore essential for traders to have a solid money management strategy in place in order to avoid large losses. There are several of these strategies available in order for forex traders to protect the capital within their account.
Using stop losses to protect a trading account
Stop losses are one of the most effective ways to protect against large losses trading forex. Offered by all brokers and platforms, stop losses act as a safety next in the case that the market moves against a trade. Stop losses can be set at any distance from the original entry price and many forex traders look for key areas to place their stops which will act as an objective level to prove that the trade has not worked. Stop losses close out a trading position by buying or selling the currency back to the market depending on whether the original position was short or long. As stop losses are executed automatically they are completely objective and also remove the difficulties that many traders have in deciding when to cut their losses for an underperforming trade and move on. This is one of the most critical decisions for an individual currency trader to make as maintaining losses at their lowest and being able to maximise profits is key to becoming profitable.
Trading forex with a set percentage of a trading account
Some forex traders will focus on achieving a set level of profits each trading day or week and many of these will also have a set loss limit. Given the tendency for markets to move rapidly throughout a trading day, it is essential that a trader recognises that market conditions may not be suitable for a current strategy and that it will be best to step aside from trading the forex markets until conditions improve. One of the best ways for forex traders to do this is to limit their losses per trading session to a maximum percentage of their trading account.
Many professional traders identify between 1-2% of a trading account as the maximum to risk on any single trade or trading session. This level is the percentage is applied to the actual capital that a trader has available in a trading account and not a percentage of the leveraged position. The idea behind risking only a small fraction of an account is that the inevitable losing days will not risk harming the overall trading account as severely as if a trader risked, say 50%, of trading capital on each trade. Needless to say, a trading account will be able to withstand a longer run of losing trades with a risk level of 2% than with 50% and allows periods where a trading strategy does not perform to be endured.
Trading strategies and market conditions
Forex trading strategies may not work in all market conditions. It is therefore important for forex traders to recognise events or situations where a strategy may not work as profitably as under normal conditions. For forex traders, big news events such as the non-farm payroll data release, and interest rate decisions of key central banks create periods of extreme volatility in the currency markets. For strategies which may be affected by these periods, it will be best for traders to avoid these periods until normal conditions return. Staying alert to global and economic developments is a key factor for many successful forex traders and can act as an effective way to avoid unnecessary trading losses.